Why Do Listed Firms Pay for Market Making in Their Own Stock?

Financial Management (Impact Factor: 1.36). 05/2012; DOI: 10.2139/ssrn.1944057

ABSTRACT A recent innovation in equity markets is the introduction of market maker services paid for by the listed companies themselves. We investigate what motivates the issuing firms to pay a cost for improving the secondary market liquidity of their listed shares. We show that a contributing factor in this decision is the likelihood that the firm will interact with the capital markets in the near future. We show that the typical firm employing a DMM is more likely to need more capital, or plan to distribute cash through stock repurchases. It is also more likely to have exit by its insiders. We also show significant reductions in liquidity risk and cost of capital for firms that hire a market maker. Firms that prior to hiring a market maker have a high loading on a liquidity risk factor, experience a reduction in liquidity risk down to a level similar to that of the larger and more liquid stocks on the exchange.

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